Financial Update (Second Quarter 2007)

Bernanke: Rules Should Not Stifle Innovation

Ben BernankeIn remarks to the Atlanta Fed's Financial Markets Conference on May 15, Fed Chairman Ben Bernanke said that in devising rules for sophisticated financial instruments, regulators should not create ad hoc measures for each new type of instrument and should be mindful of the benefits of financial innovation.

Derivatives receive scrutiny
This year's conference, held May 14–16 at Sea Island, Ga., focused on credit derivatives. Bernanke spoke via live videoconference to the gathering of academics, practitioners, regulators, and policymakers about the challenges that financial innovation poses for public policy and the nature of the appropriate regulatory response. Credit derivatives are complex instruments designed to allow the trading and hedging of credit risk.

Bernanke noted that increasing sophistication and depth in financial markets aid economic growth by channeling capital where it can be most productive. Moreover, he said, spreading risk more broadly across the financial system, which is the basic purpose of credit derivatives, has increased the resilience of the system and helped gird the economy against shocks.

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"When proposing or implementing regulation, we must seek to preserve the benefits of financial innovation even as we address the risks that may accompany that innovation," Bernanke said. Policymakers, he added, should work to devise "principles-based policy responses that can be applied consistently across the financial sector to meet clearly defined objectives."

Policymakers' goals remain unchanged
In formulating regulations, Bernanke noted that policymakers at the Fed and elsewhere have historically been guided by three fundamental objectives: financial stability, investor protection, and market integrity.

Financial stability is critical for central bankers, he said. "Policymakers cannot prevent financial shocks, but we can try to mitigate their effects by ensuring that the system remains fundamentally sound," Bernanke said. "In particular . . . we can use our supervisory authority to ensure that the large institutions that form the core of the financial system—which happen to be the leading dealers in the credit derivatives markets and the principal counterparties and creditors of hedge funds—manage the risks that they face in a safe and sound manner."

The Atlanta Fed holds the Financial Markets Conference annually to explore emerging issues that affect global financial markets and the broader economy.

May 22, 2007